Safehold helping owners drive more proceeds at lower cost in post-pandemic market

September 26, 2024

6 min read

Commercial Observer Partner Insights spoke to Jay Sugarman, chairman and CEO of Safehold, a publicly traded real estate investment trust that is creating meaningful economic opportunities for building owners and investors with a reinvented ground lease structure. The firm has been in business only since 2017 but has already amassed a portfolio valued at $6.5 billion while working primarily in the top 30 metropolitan statistical areas (MSAs) in the country.

Commercial Observer: How do you think about the challenges owners, operators and developers are facing in this current environment?

Jay Sugarman: I think the pandemic shock wave is still being felt throughout the market. What we’ve seen are higher levels of uncertainty and volatility across different marketplaces in terms of consumer behavior, government behavior, geopolitics, along with supply and demand. There’s just a lot of uncertainty and volatility post-pandemic.

Safehold’s long-term capital really helps offset that increased volatility. It’s a perfect environment for the modern ground lease structure that Safehold has created. We can help stabilize and anchor capital structures, which gives our customers the time they need to do what they do well — optimize the operating side of their multifamily, hotel or office leasing project.

How does Safehold fit into modern commercial real estate financing?

Real estate is a massive user of capital, so if you can come up with a system that delivers more proceeds with lower costs and more efficient structures, the market will come to you.

Commercial real estate historically looked at ground leases as difficult to work with — and for good reason. They were previously non-institutional and non-standardized financial instruments. In the old model, everyone had a different provision for different parts of the ground lease. We’ve standardized and institutionalized the structure to benefit the entire capital stack, so that the more people use them, the more comfortable they become.

If you show the financial world a better capital solution, you’ll create opportunities.

Safehold’s portfolio has grown to over $6.5 billion across more than 140 transactions. What are the common threads among the deals you’ve closed?

We’re working primarily in the top 30 MSAs around the country while mainly focused on large properties valued anywhere from $30 million to $1 billion.

We’ve worked across most product types, though I would say multifamily, in all its flavors, including apartment projects, student housing, age-restricted and income-restricted housing, works particularly well with our modern ground lease model.

We’ve also done deals in the office, hospitality and life science segments. Really, any product type that you see in a major urban location or near an urban location can benefit from a modern ground lease.

What competitive advantages do Safehold unlock for building owners?

We compete with other sources of traditional financing for owners, operators and developers, including mortgages, mezzanine and preferred capital, yet we also work harmoniously with each of them to offer our clients the lowest cost of capital and highest proceed solution. That’s the main competitive advantage we offer. We also think this modern ground lease is more efficient from a transaction cost perspective. We’ve structured it in a way that makes it more seamless today and in the future.

To give one example, when somebody’s developing a brand-new building, we generally offer a much lower cost of capital with a maturity profile that is much safer for a developer that may be considering taking on a short-term, floating-rate construction loan that could blow up on them in a couple years. We all know that construction can take time. Markets can change. It absolutely makes sense to us that you should pair that kind of operating risk, development risk, with a capital structure that is long-term, low-cost and very stable.

You recently announced a series of affordable housing transactions. Why is Safehold’s ground lease model so attractive to affordable housing developers?

I’m really excited about what we can do in the restricted-income, affordable housing area. Our ground lease structure helps to maximize the efficiency and impact of government resources, fill capital structure gaps for our customers, and ultimately provide more housing. In the affordable space, there’s a limited pool of Low-Income Housing Tax Credits and bond capital that’s capped every year. It’s a scarce resource. You can use these resources to capitalize the whole project, or you can use them to capitalize just the building and let us capitalize the land separately for you. This is, in effect, a way to maximize the efficiency of the traditional funding sources and, for our customers, to drive more proceeds and bridge gaps in their budgets. That’s a big win for our developers. It’s a big win for the local governments, and a big win for society.

We think there’s a big opportunity to help chip away at this housing shortage, and provide more affordable housing, without having to materially change the ecosystem that already exists. We’re going to take what exists and make it better.

How would you characterize the opportunity for Safehold in the years to come?

Commercial real estate is a huge industry that we want to make better and more efficient. If we can do that, or I should say, when we do that, we will build an irreplaceable portfolio of great land in the top cities in the United States. History tells us that will prove to be a very compelling, if not extraordinary investment. So, for us, it all starts with making the industry more capital efficient, and we think the modern Safehold ground lease does that.

We still feel like we’re learning. We’re still trying to understand how we can grow the ground lease industry to $500 billion. We’re only a few steps along that journey. But at its core, what I’ve seen over 30 years is, if you bring a better solution to the industry, it will be adopted, and it will be adopted at scale. We intend to be a big part of that future.

Unpredictable economic headwinds are creating challenging conditions for owners, lenders and buyers to have conviction in their valuations.

This is leading to a lack of liquidity in the capital markets, where owners are hesitant to sell at higher cap rates. Meanwhile, buyers and lenders are reluctant to execute transactions without a clearer sense of the cost of capital in the near term.

Consequently, the commercial real estate industry is at a crossroads, and building owners that have historically focused on traditional fee simple ownership are becoming increasingly open to more efficient capitalization strategies.

As a leader in the modern ground lease industry, Safehold helps asset owners maximize the efficiency of their capital stacks by providing low-cost capital — all while mitigating development and debt maturity risks and generating a strong return profile, said Tim Doherty, Safehold’s recently appointed Chief Investment Officer.

“Existing owners are facing refinancing at higher costs and potentially lower proceeds,” Doherty told Bisnow’s Studio B. “Developers are also seeing lower debt proceeds and higher pricing, and buyers are struggling to meet the bid-ask spread.”

Bisnow spoke with Doherty to learn more about what he is seeing in the market and the advantages of modern ground leases in all economic conditions.

Bisnow: How would you characterize the mindset of building owners and developers in this market?

Doherty: The volatile market has definitely made it difficult for owners, lenders and buyers to have confidence in their valuations, leading to a standstill in the capital markets. Owners don’t want to sell at higher cap rates, and buyers and lenders are not confident where the cost of capital will be in the near term to execute deals.

But we are seeing market transaction volume increase. People are picking their spots and executing where there is liquidity. They’re going after markets where the valuations have changed, but the fundamentals haven’t. Multifamily and industrial are great examples of product types that continue to have strong fundamentals.

Bisnow: Safehold pioneered the modern ground lease. How has the perception of ground leases changed since then?

Doherty: Pretty dramatically. When we started, the market’s perception was very different from what it is today. Before we created the modern ground lease, they were inconsistent, poorly conceived and overly complicated. We provided consistency and simplicity, taking into account the interests of all participants, including lenders and owners.

We’ve now executed over $6B on more than 135 deals across numerous markets and asset classes for different types of capital needs. This includes development, acquisition and recapitalization. It’s one thing to see the hypothetical concept. It’s another to actually see it working in practice and generating higher returns for owners, operators and developers.

With over seven years of track record, we have seen several round trips and refinancings of leasehold positions, which have demonstrated the liquidity of the leasehold position as well as the increased returns for our clients.

Bisnow: What are the key structural advantages of a modern ground lease relative to traditional real estate capital?

Doherty: It goes back to the cost of capital. We’re a low-cost provider, and cheaper than all other CRE capital available. Simplicity, consistency and a low cost of capital allow us to provide our customers with accretive, passive capital to drive better returns.

Leasehold owners benefit from less equity required upfront, eliminating friction costs throughout the term and significantly reducing refinancing risk.

Bisnow: What is your investment team focused on in the near term?

Doherty: In a volatile market, you’re always looking for sectors and deals that are actionable. You’re going into areas that are impacted on the value side, but not the fundamental side. Office has been hit on both, so that’s a very difficult one for people to peg down. You don’t know what your revenues are or what the valuation method is yet.

Residential, including multifamily, student housing and build-to-rent, is the biggest sector we’re focusing on right now because the fundamentals have not changed, even if certain markets might be seeing near-term deliveries.

Existing owners are facing refinancing at potentially less proceeds than they currently have outstanding. This is creating a capital need that can come in the form of fresh equity, such as cash in from the existing owner or new, high-priced preferred equity.

Alternatively, Safehold’s low-cost, highly accretive capital enables owners to create a more efficient, conservatively priced capital stack that reduces and, in some cases, eliminates the need for additional equity required while driving better returns.

Bisnow: How do Safehold ground leases impact leasehold liquidity when building owners sell their assets?

Doherty: We’ve seen 42 sales and refinancings behind our ground leases, so the proof of concept is there. In these transactions, the cap rates have been very similar to fee simple comparable transactions, both on multifamily and office assets, with a range of no spread on cap rate to about 10 to 15 basis points.

Having a track record on third-party market transactions has been a powerful part of the liquidity story for Safehold’s modern ground lease assets.

Bisnow: How should owners evaluate the option of a modern ground lease structure for their needs?

Doherty: We’re always here to help new clients understand the benefits for their assets as well as the liquidity track record we have seen produced with our existing clients.

In today’s current environment, we are seeing a lot of demand across all property types. The most active market is currently multifamily — acquisitions, development and recapitalization. The ground lease creates a lower blended cost of capital than fee simple stacks for all scenarios.

The added benefit today in the higher-rate environment is in recapitalizations. If an asset was purchased three years ago with 65% leverage, a 100-to-125-basis-point move in cap rates would make the debt now 85%, requiring a cash-in refinance on a fee simple basis of approximately 10% to 25% of the debt balance.

Alternatively, if the same property was recapitalized with a Safehold ground lease and a bank or agency first mortgage, the equity could refinance 100% of the in-place debt and, in some cases, take cash out upon recapitalization.

Overall, we’re still in the early innings of this business with tremendous growth potential for Safehold and our customers.